The Dollar Time Bomb Is Ticking

Dramatic U.S. debt is threatening the already fragile monetary system. Harald Schumann explains why inflation is poised to strike the United States and predicts the next financial collapse.

When finance ministers and reserve bankers of the G-20 nations gather this weekend in Paris, it threatens to be another unproductive and frustrating meeting. With great pomp, France’s president and current acting chairman of the G-20 has come up with an enormous agenda for the group that involves limiting the steep price rises for raw materials and agricultural goods, plus defusing the imbalances in global trade. At the same time, Sarkozy says, a new order for activities on foreign exchange markets is necessary in order to prevent chaotic developments in currency exchange rates and capital flows.

But the most important target for this news, the government in Washington, is giving the French driving force behind it the cold shoulder. Target zones for exchange rates and possibly even restrictions on capital flows? The barons of Wall Street don’t want to hear any of that. They’re doing just fine under the current currency (dis)order. The export-hungry Chinese, Germans and Japanese are providing them with many attractive goods at bargain-basement prices and the United States gives them American securities that pay only a paltry two to three percent interest — an excellent deal, from America’s point of view. China’s business leaders buy everything with fixed-rate dollars flooding into their country from their exports in order to prevent a rise in their own currency and to keep their prices low. They have been financing the American way of life on credit far beyond America’s own production capacity. It’s clear that America’s debt levels rise year after year by billions of dollars, but up to now, that has been a problem only for the creditors, mainly the Chinese, who have now amassed a $2 trillion foreign currency reserve, most of that in American dollars.

And U.S. Treasury Secretary Tim Geithner, along with his colleagues from Germany and Great Britain, continue on in cool ignorance of warnings from Sarkozy and his finance minister, Christine Lagarde. If China would only revalue its currency, goes the mantra from Washington and Berlin, the markets would take care of everything else.

But this position is as shortsighted as it is irresponsible. The dramatic increase in U.S. debt following the near-collapse of major American banks and the ensuing recession endangers the highly unstable monetary system. The level of debt is now nearly equal to the entire annual U.S. GDP. And new debt during the last fiscal year reached nearly 10 percent of annual GDP, rivaling the situation in Greece. The end of the debt spiral is nowhere to be seen because American voters gave the Republicans a mandate in the last election that prevents the government from increasing taxes on the wealthy while it also protects the $800 billion budget given to the armed forces. It is becoming obvious that the United States will have no means to pay its debts. Even more obvious is the fact that the declining superpower sooner or later will be left with no other option to solve its fiscal problems than for the Federal Reserve to allow inflation to run its course in order to reduce the debt and devalue the assets of its creditors.

Professionals in the bond market have long since understood those signals. Pimco, the world’s leading asset management company (and subsidiary of the German-based Allianz group) no longer buys U.S. bonds and has significantly reduced its holdings of them. Even China’s currency people have begun shedding these risky securities and are moving to euro and yen-based investments. Simultaneously, the Chinese, almost unnoticed by western market zealots, have since reduced their trade surplus by nearly 50 percent and no longer need to export so much in order to keep its currency stable. All this has not resulted in drastic interest rate increases on U.S. bonds because the Federal Reserve meanwhile created over a trillion dollars out of thin air and bought its own government’s debt. The Fed is now officially America’s biggest creditor, surpassing even China.

But as early as June, this public financing via money creation will come to an end. At least that was the announcement made by the Federal Reserve’s Ben Bernanke. If that doesn’t result in sufficient buyers for U.S. securities, it could have dramatic effects. Not only would U.S. interest rates quickly rise and thereby push the economy again into recession; it’s also feared that domestic as well as foreign investors would panic in the face of a possible U.S. dollar nosedive and unload their bonds, causing imbalances in markets and among banks. It hasn’t yet come to that, but it may. Therefore it would be urgently necessary to develop a plan now that could be used in the event of such a scenario. To that would also belong a concept to be used by the currency rulers in Beijing, Tokyo, Washington and Frankfurt allowing them to coordinate their monetary and exchange policies so everyone could benefit from a stable currency system instead of sabotaging one another in the name of national interest. If exchange rate target zones or controls over the movement of capital are necessary, then so be it. Ignoring everything and postponing problem solution with advice coming from pointless working groups like the small-minded G-20 is certainly not the answer. The dollar time bomb is ticking and sooner or later it will explode.

Globalization creates an ever-growing interdependence of nations and their economies. This simple fact was the reason the G-20 came into being in the first place. Hopefully, the financial system doesn’t have to collapse yet again in order for those in charge to learn their lesson.